In the Union Budget 2019, the Finance Minister announced plans for issue of $10 billion of sovereign bonds. Amidst the fanfare, the logic was perfect. By relying on foreign currency bonds, the government will hit two birds with one stone. On the one hand, it will ensure dollar inflow and help to protect the rupee. On the other hand, it will reduce the pressure on the local bond markets and ensure that private borrowers are able to borrow at lower rates. A great idea seems to have suddenly run into rough weather. Here is why.

PMO advises caution

While it could not be confirmed, Reuters had reported that the sovereign bonds may have run into rough weather due to objections from the PMO. For a long time, the PMO has been a sounding board for all major decisions and has used its discretion to bring certain ideas into question. That is exactly what the PMO apparently did in this case. What the PMO has apparently done in this case is to ask the Finance Ministry and the key bureaucrats to rethink the idea due to its larger currency implications. Since the sovereign bonds are denominated in dollars, there is the risk that any weakening of the rupee versus the dollar could increase the burden. This will not only impact the external ratings of India but also create a vicious cycle of rupee weakening. It is precisely for this reason that the PMO has asked the finance ministry for a rethink!

Here are the risks

If the PMO has called for a rethink on the sovereign bond issue, there are several reasons for the same. Firstly, the Indian rupee has in the past shown a tendency to rapidly lose value. We saw that in 2008, again in 2013 and more recently in 2018. On each of these occasions, the rupee depreciation was in the range of 20-25% and that is hardly going to look too good when you have $10 billion of bonds payable. Secondly, these bonds are listed on international markets and that opens up the Indian government securities to listing and trading in an alien environment. The RBI and the Finance Ministry have little control over what happens to the bonds once they are traded in an international market. That surely is a big risk!

What are the options now?

For an economy that is still not used to global bond volatility, India will have to tread a lot more carefully. We have seen the impact of risk on large economies like Spain, Italy and Greece in the past. For an economy that is already running a current account deficit of closer to 2% and a fiscal deficit that is inching towards 4%, this could be too much of a hassle. Rather, India can focus on its traditional NRI deposits and FPI flows into debt. Here there is no currency risk on the government and Indian regulator has a lot more control. The PMO may be absolutely on target in its view! ©